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MND NewsWire features plain and simple interpretations of industry related data and events written in a manner that maintains the interest of random readers while still catering to the perspective of a housing market professional.

Fitch
Ratings warned today that billions of prime and Alt-A mortgages that were
written as interest-only (IO) loans are due to recast over the next two years. $47
billion of these loans convert to fully amortizing loans in the next 12 months
and a total of $80 billion in Prime and Alt-A loans and another $50 billion
Subprime loans will recast by the end of 2011. These conversions will result in
substantially higher monthly payments.

While IO options were written
into both fixed rate (FRM) and adjustable rate mortgages (ARM), over 90 percent
of the loans in each category, prime, Alt-A, and subprime, are ARMs because
those offered borrowers the lowest payments and many borrowers qualified only
because of these artificially low payments. In addition, 63% of Prime and Alt-A loans qualified based
on less than a full documentation of income.

As MND
reported, in September Fitch warned that $134 billion in Option ARMs would
recast by the end of 2010. Option ARMs are mortgages that allow the borrower to
choose each month among making a fully amortizing payment, an interest only
payment, or a smaller payment that does not cover all of the interest. In the
last case the remaining interest is added to the mortgage balance. Fitch estimated that 94 percent of Option
borrowers had exercised the lowest payment option, allowing the loan to negatively
amortize. These loans will recast both
as fully amortizing loans and at a higher balance than the borrower qualified for.

Because interest rates have
remained low, many of the IO loans due to recast will have payment increases
only to the extent necessary to begin amortizing and some may actually have the
payment shock mitigated by a lower interest rate. However, many Subprime loans have an interest
rate floor that does not allow the rate to drop below the initial one and, in
subsequent years, all borrowers will probably suffer additional payment shock
as their loans go through periodic rate adjustments. Just considering the
amortization component or the recast, current average payment shocks are estimated at 15%, and each 1% rise
in the benchmark rates corresponds to an approximate 10% increase in payment
shock.

While
historically only 3.3 percent of Prime loans have been seriously delinquent
prior to recast, the 60 day delinquent rate rose to 9.3 percent within a
year. Alt-A loan delinquencies have
increased from 12 percent to 29 percent and Subprime loans from 20 percent to
58 percent. In the current climate borrowers also have less incentive to
continue payments as their equity has significantly eroded or disappeared.

IO loans account for only 8
percent of the non-agency RMBS market so the impact of expected defaults on
these loans will be relatively small. However, in certain securitizations the
concentration of IOs can be greater than 50 percent. These securitizations
could be at risk, particularly if large numbers of IOs recast at the same time.
Fitch pointed out that performance on these pools will be particularly hard-hit
by recasts. If observed IO performance results in higher than expected loss
estimates for Fitch-rated RMBS, this may result in further negative pressure on
long-term ratings and/or Recovery Ratings (RRs).

Fitch Ratings Managing
Director Roelof Slump said "60-day delinquency rates have risen over 250%
in the 12 months following previous recasts for prime and Alt-A loans,' said
Slump. Even though Fitch's current ratings consider the risks of upcoming IO
recasts, 'mortgage pools with significant interest-only loan concentrations may
be downgraded if performance is worse than anticipated."

Comments

Jan--I'm curious-I know that Option ARM recasts are also an issue--I had an account rep tell me that not only will the rates adjust on the option arms, but the "negative equity" must be cured within 12 months of the recast.
In other words: if the house is now $100,000 upside down, will the borrower have to pay the $100k in 12 months, PLUS the monthly payment increase from going to the fully amortized balance? That can't be right can it?

depends on the paperwork. sounds like a reasonable possibility. man, what an opportunity...not sure how or exactly what but every crisis contains the seeds of an opportunity and there is a massive crisis going on in finance.

Frank - that's not even close to true. The recast on an Option ARM is limited to the following:
1. Payment options on the loan disappear, and the new payment is amortized over the remainder of the 30 year term. E.g., if it had a 5-year recast, the remainder of the balance, neg am and all, is repaid over the remaining 25 years.
2. The new payments will be calculated at the prevailing rate at the time of recast, as per the note. Usually 12-MTA plus 2.5% or so (rates are around 3% on these loans right now), or some variance of LIBOR plus a similar margin.
An Option ARM can also recast when the principal balance reaches a certain percentage of the original loan amount, like 110%, 115%, or 125%. So it can recast prior to the 5 year recast date, if it has negatively amortized to that extent. However, these loans typically had some protection in them because the minimum payments increased each year normally. That limited the neg am somewhat. Also, even if the consumer was making the minimum payment, it is possible that the underlying rate of interest on the loan be low enough that the minimum payment actually causes the loan balance to be paid down.
Option ARMs were a great financial planning tool, if used properly in the right person's hands. I have one myself, I have a 3% rate on it right now, and the minimum payment option has enabled me to invest the cash savings in other investment vehicles.

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